Startup Equity: But Can’t I Pay Less Cash? (Part 12 in an n part series)

This series of articles* has covered a lot of ground, but this particular article touches on a critical component that we have not really discussed. When equity first began to be used in Silicon Valley, prior to the boom of the late-1980’s, the goal was getting senior players to have some skin in the game. This is still a major objective of equity.

As the stock market took off in the late 1980’s and flew through the 1990’s, equity became a cheap replacement for cash. The accounting rules ensured equity barely touched companies’ books. The stock market ensured that equity delivered far more, far faster that any form cash compensation. These high growth companies were able to keep cash pay low. This allowed the to easily compete for talent against large mature companies. This is no longer the case.

Many things have changed since the 1990’s. When it comes to equity compensation, the biggest change is that you only see lower cash pay at the earliest of startups. Far more Angel and Venture Capital money is being spent on staff than in the past. This means that less is going to research and development, or larger investments are required to build companies with no better potential than those in the past.

Remember that the accepted “value” of startups is based on recent investment rounds. Very few consider that a far great percentage of these investment rounds is being spent on staff than ever before. In fact, below the very top roles, we see very little differentiation in pay between public and private companies. The startup discount no longer exists for most industries.

What does this mean if you are an executive, HR leader of compensation professional? First, you need to budget the essentially the same base pay, and perhaps cash short-term incentives regardless of whether you have just finished your B-Round or your IPO. Second it means you need to be far better at using equity intelligently and efficiently. You can no longer throw a basic equity plan out there and expect to also get away with sub-par salaries.

Add to all of this the rapidly changing workplace and experience. Companies are spreading out more quickly. Employees at all levels are looking for more workplace (and time) flexibility. Housing prices are skyrocketing in nearly every location where equity compensation is a strong component of total rewards. The fundamental equation has changed and companies, and their leaders, must learn and adapt. They must understand that the bargain garage-based startup is far different when a garage now costs $1 Million.

So, in answer to the question: “How much less can I may my employees if I also give them reasonable equity?” If you are a typical startup, equity will not give you any direct cash savings. Of course, if you are in any industry where equity is uncommon it may still have some capability to reduce cash pay, but those industries are becoming increasingly rare.

The next pieces of this series will touch upon some of the most technical equity issues that are often not included in terms of compensation. These include: Call and Put Rights, Drag Along and Tag Along Rights and Rights of First Refusal. Let me know what else interests you in the space as I am wrapping up this series in the not so distant future.

*Other articles in the “Startup Equity” Series (1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11) 

Dan Walter, CECP, CEP is the President and CEO of Performensation. He is passionately committed to aligning pay with company strategy and culture and considered a leading expert on equity compensation issues. Dan will be presenting at the NCEO “Staying Private” conference 3/7/17 in Santa Clara, CA. Dan has written several industry resources including a recent Performance-Based Equity Compensation issue brief. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @Performensation.

Comments

[jay]

Dan, you are the 'Energizer Bunny' working away and putting up some great stuff all the time. This 'series' of posts could make a 'super' e-book if you have not thought of that. I have enjoyed your contributions greatly.

This is my 'last intervention' to this blog. I believe it is time for me to congratulate you all for a wonderful contribution to the field and move on at last.

I will look in from time-to-time and cheer you all on with silent cheers going forward.

[Dan Walter]

Thanks so much Jay! I can't tell you how much I appreciate that, especially coming from you. I was going to make my necxt post on this topic my last post in the series, but then I realized that some people may not like a "13 part" series. My guess it will be 14 when complete.

I may turn these, with a bit of connective narrative and a technical appendix, into an ebook. I think that this is an area that need more attention.